Prof. M.

Pachayappan Internal Material: Not for Circulation

Hewlett-Packard

Hewlett-Packard (HP) grew from its roots as an engineering and medical company to an information
technology corporation. In 1999, HP spun off its engineering and medical businesses as Agilent. In
2002, HP merged with Compaq Computers, becoming a major player in desktops, notebooks and
servers.

Mark Hurd, HP’s current CEO, refocused the company away from building and marketing the PC
as a commodity item. Besides making PCs more attractive to consumers, HP included user-friendly
features, such as the ability to check email and appointments without having to wait for the machine
to boot up. HP’s marketing team pitched their PCs as a personal reflection of consumers’ desires and
needs. Using the tagline, “The computer is personal again,” HP developed advertisements featuring
entertainers such as Shawn “Jay-Z” Carter. HP’s Personal Systems Group (PSG) included sales of
PCs, handheld devices, digital entertainment systems, calculators and related accessories, software
and services. Desktops and notebooks represented more than 90 per cent of PSG’s revenue and gross
profit. In 2007, PSG represented approximately 35 per cent of HP’s revenues and 18.3 per cent of
operating profits.

HP branded its PCs based on the customer segment served. The company’s HP Compaq products
were sold into the commercial market, while its HP Pavilion and Compaq Presario products targeted
consumers. In the consumer segment, the HP Pavilion line was the high-end brand, positioned above
the Compaq Presario products. Analysts expected HP’s PSG group to maintain operating margins
of between 5.1 and
5.4 per cent from 2008 to 2010. HP’s PCs were sold through a retail network of approximately
80,000 stores. In PCs, HP’s large presence in the consumer retail market for notebooks positioned
the company to take advantage of industry growth in the shift to mobility. In addition, the majority
of HP’s PC growth in recent years was a result of sales through its indirect distribution channel —
70,000 third-party resellers who sold HP services as part of their solutions.

HP outsourced most of its manufacturing to contract manufacturers, including Flextronics, Celestica,

Solectron, Sanmina and Jabil Circuit for desktop PCs and servers, and Taiwan-based original design
manufacturers (ODMs) Quanta, Inventec, Wistron and Compal for notebook PCs. HP utilized Intel
and AMD processors for the company’s desktop and notebook product lines. Hard disk drives were
supplied by Seagate and Western Digital. HP relied on Intel, AMD, Canon and Hitachi for much of
its research and development (R&D). Given that the company outsourced the bulk of its
manufacturing and R&D, HP could manage costs and avoid significant margin decreases in a
slowing demand environment. See Exhibit 7 for an overview of HP’s supply chain.

From 2004 to 2006, PSG’s margin improved by 300 basis points, a result of increased leverage with
Intel as HP started to use AMD processes (150 basis points); supply chain improvements and
leveraging of purchasing across divisions to secure lower pricing on components such as hard disk
drives, panels and memory (100 basis points) and a broader selection of notebooks (50 basis points).
To enhance its service business, HP announced in May 2008 that it was purchasing EDS for $13.9
billion. On one hand, EDS enhanced HP’s offerings in IT and applications outsourcing. There was
also the potential for significant cost synergies, or shifting general & administrative costs offshore.
In addition, synergies would come from improvements in supply chain, real estate, and process
improvement. On the other hand, analysts believed that turning around EDS would be a distraction
to HP.
Prof. M. Pachayappan Internal Material: Not for Circulation